Who wouldn’t want to insure their life? It’s quite possibly one of the most valuable things I own and I would certainly like to be protected in the event I lose or misplace it right? Well, if you’ve gotten over the morbidity of the idea of buying life insurance and “shopped” around, you probably did exactly what I did – gotten thoroughly confused. What the heck is term life insurance and whole life insurance? What’s the difference between variable and universal? The worst part is that none of them are named in a way that makes it clear what exactly you’re getting. So, since one of my goals for 2008 was to figure out all these insurances and makes sure I’m covered, I’m forced to research it and try to decipher this complicated and likely very lucrative business.

Term Life Insurance

Term life insurance is claimed to be the easiest of the life insurances to understand and is named “term” because you are protected for a certain period of time – a term. The idea behind this insurance is that you can cover a small period of time with a lot of coverage and little cost. The idea is that you could use this insurance to protect yourself if you take on a large debt, such as a mortgage. For example, let’s say you just signed up for a 30 year mortgage and you are the sole source of income for your family. You could use term life insurance to cover the balance of the loan for a set period of time so that your family wouldn’t be in trouble if something were to happen to you.

Whole Life Insurance

Whole life insurance means coverage for your entire life, as long as you continue to pay the premiums on time. Sometimes you can convert a term life insurance policy into a whole life insurance policy, so that’s always an option if you want to. As for the premiums, this is where the companies try to get you in early so that the payments stay pretty level as you grow older. Since you are less riskier when you’re young, the earlier payments essentially offset your later payments as you become older and riskier. The other main difference is that there is a guaranteed cash value for the policy that you can actually borrow from. As you pay premiums, a portion of that goes into the guaranteed cash value bucket that is available to you if you decide to surrender the policy later. How much and how quickly that accrues depends on the type of policy you have and other factors.

Universal Life Insurance

Another name for this is Flexible Premium Adjustable Life Insurance (universal life just sounds better). This is a flexible version of whole life insurance where you get the savings element of whole life. The insurance company will invest your savings, offer a guaranteed minimum, and you get those funds tax deferred. What’s flexible is that there are two death benefit options. The first is that they pay out the policy’s cash value. The second option is that they pay out the face amount of the contract plus any cash value you accumulated. The first option is cheaper because the company pays out less insurance and the second is more expensive because they pay out more. I’ll be entirely honest, I don’t fully understand this and this article is designed as a brief overview.

Variable Life Insurance

This is also called Variable Appreciable Life Insurance and it is basically part life insurance and part investment account. The variable refers to the idea that you can specify a percentage of your premium to go towards a separate investment account that can appreciate (or depreciate). While some places will claim there’s a minimum, since it is partly an investment, it is governed by the SEC and you get a prospectus with the policy. What’s nice about it is that you can get tax-free appreciation, until you end the policy, and the appreciation can go towards your premiums. The risk is that there is always a risk when it comes to investing (as you probably are feeling if you’re currently in the market, this month has been brutal).

There are a ton more types of insurances out there but these are the big four categories and I believe I’ve gotten their basics correct. If any of you have any expertise in this, please add clarification or corrections in the comments.

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The variable Life Insurance is usually called Variable Universal Life Insurance (VUL). Unless you have a lot of money, this should more than likely be avoided. Sure, you can invest and have tax-free appreciation, but these accounts are usually have a bunch of fees/loads.

If you can max out your 401K + IRA and have no debt (including a mortgage), and still have money left over to invest, and you’re looking for tax shelter and you need life insurance, then maybe this would make sense, but even then you might be better off with just buying term, and opening a regular brokerage account.

VULs are very lucrative to the Insurance company and agents, so you may be presented with one, and told how good it is, but it’s only good for a few people. If you’re like me, and go to a big company for financial advice, pay close attention to what they’re selling (unless it’s fee only advisers, they are salesmen). I went to one, and the guy started pushing the VUL. I didn’t know much back then, and it sounded good. Only after there were other red flags that I started to investigate and learn about it, and realize what a rip-off it was for me (I was 25, and had a net worth of maybe 15K at the time).

My husband and I were just talking about this. He has a $100K whole life policy that his dad signed him up for years ago. He has been paying about $600 a year into this policy for more than 10 years now. I personally don’t see the value of continuing to pay into it, to get…$100K in the future?! Wouldn’t it be better for us to invest that $600 annual amount ourselves?

Serendipity do. Last year my partner and wife, T., and I went through this very same process and ended up with a combination of whole life and convertible term insurance. Since then, I have been meaning to go back over all of our research and verify that we made the correct choice for her. One of the agents we talked to at AAA told us this one rule of thumb. You get this kind of insurance because you owe someone or you love someone. We didn’t buy from them but we did keep this in mind as we shopped and studied. I look forward to discussing this with you.

Hmmmm. I haven’t bothered to figure out life insurance, but I need to soon. I’m glad you’re writing about it as you learn, but this article raised more questions than answered. “Who wouldn’t want to insure their life?” Well, insurance is management of risk. Insurance company charges a premium that is a fraction of the value of the item being insured, because chances are, the risks of loss of or damage to the item are small. But it’s absolutely certain that my life will be lost at some point in time. So how does this work, anyway? What exactly is being insured? What is “contract amount”?

Why is life insurance a lucrative business? From the consumer’s point of view, what are the catches?

For term life, you mention that it could be used if you take on a large debt such as mortgage. Does this apply to the other kinds of life insurance? If not, what are the typical situations for the use of those kinds?

In response to “Lonely planet”
The only scam being pulled is the collective denial of our population.
As the child of an unisured parent who passed away too soon, I can atest to the need for people to properly insure themselves.
in response to Grace: that 100K whole life is probably less than the amount you need. commonly people assess their insurance needs as 2-7X their income as to replace the bread earners income. Let me ask you, and I know your going to take this the wrong way but…how long do you or your husband intend to be dead? More appropriate would be 20X income, here’s why…lets say your husband makes 100K a year, your husband should be insured for no less than 2 million dollars because if you took that 2 million dollars and put it into a high yield savings account churning out 5% a year, you would be able to replace your husbands income for life. Income that will pay for the mortgage, put the kids through school and allow you and the children to live a life of dignity instead of having your hand out to friends and family when they forclose on your home (I LIVED IT!). Then after all of your obligations are paid the kids are through school you can throw your daughter a wonderful wedding and retire comfotably as if your husband was still by your side. Imagine then how much you’ll be thanking your husband for his forethought.

If your worried about spending too much as you may with a total whole life insurance portfolio, then use term to supplement it. Because it can be purchased at much less expensive rates than Whole life….also I should ask, are you insured, because If your the type of person that feels responsible for their family then you need to consider your value to the family equasion. As for investing the money, Remember most investing programs involve taxes…LIfe insurance is generally (I say generally because of the VUL contracts) TAX FREE to the beneficiaries, free from estate, and income taxes.
Not only that but most investment programs come with no Guarantees, None you can put 600 dollars a year into an investment program and come away with nothing!…LIFE INSURANCE IS ALL ABOUT GUARANTEES..find me an investment program with guarantees…there are NONE!

put that in your pipe and smoke it!

Sorry to be wordy here…but it continues.

The affluent among us use life insurance as to offset the estate or death tax, for those of us with assets of over two million dollars be aware that a 50% estate tax is imposed to your heirs upon your death. That tax bill must be satisfied within 9 months.
So in an effort to offset the fire sale of assets within an estate that they have worked a lifetime to build, a joint survivorship (second to die) policy can be issued on both spouses so that families can still pass assets and build generational wealth.

Yes I am a Life insurance agent, guy, scumbag…whatever you want to call it. But I do this because no-one should have to live the nightmare that me and my siblings faced. This is not only my job but my mission.

I totally agree with you! I am currently studying Life and Health and I also work for State Farm and I can honestly say people look at the insurance business the WRONG way! Life insurance is an investment and if you truely care about your family, you’d buy it! Customers look at this as a sales pitch, but it’s actually REALITY!

You guys crack me up…this argument has been going on for years. Just wanted to clear up a couple things.
Ryan- death benefits are income tax free to the beneficiary’s, but count to the estate of the dead person if the policy was not held in an ilit. Once the benes recieve the proceeds, then that money is part of their estate for tax purposes.

I have made 3 death claim calls. The widow asked two questions. Is that all there is? and, Are you sure? Notice she didnt ask”was this term, or vul or whole because she doesnt care! She just wants the cash, her loved one is dead and she has bills to pay!

98 percent of the population needs term and 25% of those folks can supplement a little(50-100k) with Perm. Insurance is not an investment and congress can take away the tax free build up of life insurance at any time, beware.

Yup, Thanks for expanding on the ILIT. I wasn’t intending to run an advanced course I was just ranting. I’m sure your deal with the publics denial for the need yourself. I agree with your feelings on term but there are situations where the others can be used within your portfolio, I’m not a fan of VULs though). Insurance needs to be safe, invest elsewhere.

Ryan it is unfortunate that your family grew up in a time and a society that said the man works at the office, the woman (should I say “little” here?) stayed at home. It sounds like your mom, like many women of that era was totally unprepared to go out into the big world and take care of business. Phillip Wiley explained the sort of thinking that went into this practice in his essay on Momism back in the 60′s. Since Lonely Planet seems to have tapped into your emotion, she (I’m guessing here) also seems to have tapped into your latent predjucice against women. Too bad because you sound like you know insurance and do just want to help people.

Meanwhile, Lonely Planet, either your cap lock was stuck or you been sold some bad shit by someone who only rule was caveat emptor. Still, researching a subject is really a good thing to do if you’re managing your own finances so maybe we could think of Ryan’s commentary as part of the research?

Term life insurance does offer an affordable option for most younger people on a budget who need the maximum amount of protection for a limited period of time, such as, 10-30 years.

The drawback with term life is that once you outlive your policy, you need to re-apply for a new policy at higher rates, if you meet the health requirements. Unless, you have the renewability option included in your policy. But then, the rates will still be a lot higher.

Life insurance indeed can be very confusing. Basically in a nut shell, term life insurance is, by definition, temporary insurance. Each year, a premium is paid to cover the risk of death during that year. Term life insurance has no cash value. The only way to collect anything is to die during before the term life insurance expires. If death occurs, the life insurance beneficiary generally collects the death benefit of the life insurance policy, free of income tax.

A permanent life insurance policy is a policy that provides life insurance coverage throughout the insured’s lifetime – the policy never ends as long as the premiums are paid. In addition, a permanent life insurance policy provides a savings element that builds cash value.

So, which one do you need? That depends on several factors. First, the best type of life insurance to own is the kind that is in force when you die. It is a fact, that most permanent policies lapse because they are 3xs more expensive than a term life insurance policy. If you can’t afford thousands per year, then you should consider a term life insurance policy.

Byron:
My husband had a Level Term Life Insurance renewal annually until age 100; he passed this past May, 09 and I received a 1099-R from his insurance company for the death benefit proceeds informing me they are taxable. I thought you said they are not. Do you know if they are and why insurance company would send me a 1099-R?

I recently purchased a term life insurance policy for my sister. She has no money and I know she doesn’t have life insurance. I did this to spare my mother the expense of paying for a funeral. (my sister is in her early forties, but morbidly obese. I received the policy in the mail and I’m not sure exactly what it means? Can you please explain what “Group Step Rate-Term to 80 means? It also has two columns, both titled Rider = 10,000 and a column titled accidental death $25,000
I only purchased $10,000 My intention is to have enough to bury her, nothing else.

Have you received a reply back for your question I’ve been having insurance on my mother step-rate-term and she called her company the other day they told her the policy will expire when she is 80 she is 75 no and in good health so if she live past 80 she is without insurance I’ve had the policy since 2004.

Im a little late in posting. But I feel that ones personal situation and intention/need is the biggest factor. Put out scenarios for yourself first, and present them with your questions.
One thing to never assume is that if you are “rich” that you will still be rich.

I did not see annuity’s mentioned. But my food for thought is, my experience. This is planning for your loved ones after you die or when you die unexpectedly. Will they have immediate access to your funds in any other account to pay your funeral, and bills off, and whatever else you want to provide them as a passing gift? If not, get the insurance. Does your employer provide? MOST IMPORTANTLY, who you list as beneficiaries on ALL your money accounts you own past and present, including your pension will get that money immediately if they are listed. If they are not listed, it is a MESS! and a costly mess believe me. From my experience. Also, my dad made “any funeral home” his beneficiary on a life insurance policy that grew. He put the policy in his “funeral” file, and we gave it to the funeral home, and it was smooth and easy. The funeral was paid for out of those funds. (about 4,000 is what we got out of it) but many don’t think of that. Just don’t loose the policy and make sure they know about it, before the funeral. Also if you have no kids or hubby like me, all I need to do is worry about emergency funds if I become unable to work, and about my siblings being able to pay off my estate bills. But they can just use the beneficiary money out of other accounts. But if you have a mate or kids to be concerned with, I was told whole life ins annuity is best. So look into that. PS the beneficiary AND CONTINGENT lists is a KEY thing to remember to look into on all accounts first and foremost. For example, my dad put my mom as sole beneficiary on an account, well….my mom passed in 06, and he “forgot” to update it to put his children, so….. now we have to pay ESTATE tax rate on the money and a more costly manner of obtaining the money as well. One account where we were listed, the money came to us after one form, within weeks, it was taxible, but at least only at our rates, not estate rate. Sorry if I got off subject, but these facts can help in determining if life ins. is really needed.

FYI: My husband had a VUL policy with our two sons as riders, the policy was started when my children were age 1 and 3. Ten years later we decided to switch to a Term Policy at a higher coverage. My children turn out to be uninsurable because my oldest son Hign Functioning Autistic (no medication) and the younger child has ADHD (he is on Statra). The only choice we had was for them to have a individual VUL policy from the insurance company that had insured them prior. I was shocked at the lack of choices.

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